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Maker DAO - Central Bank of Crypto Assets
Preface
Decentralized Finance is steadily reshaping the TradFi system and opening up a new financial environment. After Bitcoin, new value propositions led by Decentralized Finance continue to emerge, with lending protocols, Decentralized Exchanges (DEX), Farm yield, and stake at the forefront of financial innovation.
In many Decentralized Finance applications, the role of Stable Coin is particularly important. Stable Coin is crucial to ensuring the normal operation of Decentralized Finance and the entire encryption field. Core Stable Coins such as USDC, USDT, and DAI play a key role in maintaining market stability in the Cryptocurrency market, providing traders and investors with effective means to avoid market Fluctuation. MakerDAO is committed to integrating Stable Coin generation with Decentralized Finance lending, aiming to create an ideal environment for Decentralized Finance and its development. As of September 9, 2024, MakerDAO TVL is $5.122B. On August 27, MakerDAO announced a rebranding to Sky Protocol, with significant upgrades to its governance Token MKR and Stable Coin DAI. MKR will be upgraded to the new governance Token SKY, while DAI will be upgraded to the new Stable Coin USDS (Sky Dollar). The following section will introduce the pre-upgrade MakerDAO.
What is MakerDAO?
MakerDAO is an Ethereum-based protocol designed to maintain the stability of DAI through decentralization. DAI is a stablecoin pegged to the US dollar and backed by the Maker protocol. Users can generate DAI by locking encrypted assets such as BTC and ETH and retrieve the collateralized assets when needed. This system eliminates the reliance on traditional centralized financial institutions, allowing users to have more autonomy in managing their currency.
The Maker protocol relies on two core tokens: DAI and MKR. DAI is a stablecoin generated by collateralized assets, while MKR is a governance token that grants holders the right to vote on protocol proposals. MKR holders can adjust core parameters such as interest rate and debt ceiling through voting to ensure the smooth operation of the protocol.
Unlike the TradFi system, MakerDAO's decision-making process is jointly managed by the community, with a more decentralized governance process. This open governance structure avoids the opacity and unfairness that traditional centralized Financial Institutions may bring.
What is DAI?
DAI is a specific type of cryptocurrency generated by the MakerDAO system, and its core feature is to maintain a soft peg with the US dollar, where 1 DAI is approximately equal to 1 US dollar. As a stablecoin, the value of DAI is relatively stable and does not have the strong volatility like other cryptocurrencies such as BTC or Ethereum. Therefore, it has been widely used in the Decentralized Finance ecosystem and beyond. The stability of DAI is maintained through a trap algorithm mechanism - any user generating or borrowing DAI must open a collateral vault on the Maker platform and deposit relevant assets as collateral. The value of the collateral must always be higher than the amount of DAI generated. If the value of the collateral drops to the critical point, the smart contract will automatically trigger liquidation.
Main Functions of MakerDAO
In the Decentralized Finance ecosystem, MakerDAO and its DAI Stablecoin are widely recognized for their extensive use cases (including lending, trading, and serving as a stable value storage tool during market Fluctuation). Here are some key features of MakerDAO:
DAI Stable Coin DAI is a Cryptocurrency stablecoin pegged to the US dollar, aiming to maintain a 1-1 Exchange Rate with the US dollar. Unlike stablecoins issued by traditional Financial Institutions, DAI's Collateral is primarily BTC, ETH, and other assets approved by MKR holders. Users generate DAI by locking Collateral on the MakerDAO platform, obtaining a decentralized and collateral-supported stablecoin.
Collateralized Debt Position (CDP) The process of generating DAI requires users to create a Collateralized Debt Position (CDP) on the MakerDAO platform. This smart contract allows users to lock their assets as Collateral and generate a corresponding amount of DAI based on the value of the collateralized assets. Users must maintain a certain collateralization ratio to ensure system stability. If the value of the collateralized assets falls below a certain threshold, the CDP will be liquidated and the locked Collateral will be auctioned to repay the debt.
MKR Token In addition to DAI, MakerDAO also has governance token MKR. MKR holders play a key role in platform governance, responsible for making decisions related to parameter setting, risk management, and system governance. MKR is also used to pay fees and fines within the system. When a CDP is liquidated, part of the collateral is used to repurchase and destroy MKR, thereby reducing token supply.
Governance and Voting MKR holders participate directly in MakerDAO's governance by voting on platform proposals and parameter adjustments. The decentralized governance mechanism allows the community to collectively decide on the stability fee (i.e. the interest rate for generating DAI), acceptable types of collateral, and other key parameters.
Decentralization and Stability MakerDAO aims to provide a stablecoin (DAI) that is not dependent on centralized institutions or the TradFi system to enhance market stability. Its Decentralization and transparency design can reduce manipulation risks and ensure the stable value of DAI.
Transparency MakerDAO operates on-chain, and the operational process of the system is highly transparent and auditable. Users can track the issuance and circulation of DAI through the blockchain, ensuring the overall transparency of the system.
Token Upgrade Rules
The release of MakerDAO's Token and product will take place on September 18, 2024. The update of the Token after the brand upgrade mainly involves the following two Tokens.
USDS
USDS will be the upgraded stablecoin in the Sky ecosystem.
USDS can be upgraded from Dai, or converted from USDC at a 1:1 ratio, and USDS can also be converted back to Dai. The upgrade of the Token is a voluntary choice for users.
SKY
The governance token of the Sky ecosystem is SKY.
MKR holders can upgrade MKR to SKY, and SKY can also be converted back to MKR. During the token upgrade, each MKR token held by the user can receive 24,000 SKY tokens. The token upgrade is voluntary.
DAI Token Economic System
As a core component of the MakerDAO ecosystem, the economic system of DAI Token relies on complex mechanisms to maintain the value of DAI stable at around 1 US dollar. The following are several key elements of the DAI Token economic system:
Application Scenarios of DAI
The stability of DAI gives it a wide range of applications. As a stable store of value, DAI is widely used in the hedging market to avoid the risks of cryptocurrency price fluctuations. In decentralized trading, traders use DAI as the unit of account to provide relatively stable trading pairs. DAI is also one of the core assets of decentralized finance lending platforms. Users can borrow DAI by collateralizing assets and benefit from its stable value, without worrying about fluctuations in the value when repaying the loan.
DAI also plays an important role in providing liquidity and earning money laundering and rewards for DeFi users by providing DAI to Decentralization exchanges (DEX) and liquidity pools. Its stability makes it the preferred asset for liquidity providers. At the same time, DAI is widely used for cross-border remittances and international payments, and its low fees and price stability make it an ideal choice for transferring value.
For enterprises and individuals, DAI can help mitigate the price Fluctuation risk faced when holding other digital assets. For example, businesses or individuals accepting Cryptocurrency payments can convert funds to DAI to ensure the value of the funds will not fluctuate due to market Fluctuation. In addition, many DAPPs and blockchain projects have integrated DAI as the stable currency in their ecosystems to further enhance platform usability and user experience.
How does MakerDAO work?
MakerDAO's governance is dominated by MKR Tokenholders. MKR holders vote on critical decisions through 'executive voting', and if a proposal is passed, the corresponding code will be modified to implement the proposal. Before the executive voting, proposals need to undergo a preliminary assessment by the community, known as signal voting. Although anyone can propose on the MakerDAO forum, only MKR holders can vote on these proposals, and the voting weight is based on the amount of Tokens held, not the number of holders.
MKR holders are also responsible for setting the DAI Intrerest Rate (DSR), which is the interest rate that DAI holders can earn when they save DAI on the platform. When the price of DAI is above 1 USD, the Intrerest Rate for savings is usually lowered to reduce demand; when the price of DAI is below 1 USD, the Intrerest Rate for savings is increased to stimulate demand.
The process of generating DAI involves depositing Ethereum (ETH) or other approved Crypto Assets into MakerDAO's Smart Contract, with these assets serving as Collateral to generate DAI. The value of Collateral required to generate DAI must be at least 150% of the generated DAI. If the value of Collateral falls below this ratio, the Collateralized Debt Position (CDP) will be liquidated, and the Collateral will be sold to repay the DAI debt and associated fees. The DAI Savings Rate (DSR) allows users to earn Interest by locking DAI, which is funded by the stability fee charged at the time of generating DAI.
Relevant Data
In 2020, MakerDAO used 6s Capital, a real estate development collateralized loan project, to build an RWA vault, and partnered with the RWA-based lending platform Centrifuge to tokenize the collateral. In the Endgame plan released by MakerDAO in May 2022, it also emphasizes that one of the key parts of MakerDAO's construction of a stable currency with Decentralization is to use RWA as Collateral.
According to MakerBurn's data, there are currently a total of 11 RWA projects with $1.25 billion worth of assets as collateral for MakerDAO.
Maker DAO launched the PSM (Peg-Stability Module) for DAI Liquidity in July 20th, aiming to provide bilateral buffer protection for the price of DAI. Users can deposit Stable Coin assets supported by the protocol, such as USDC, and mint DAI at a fixed exchange rate of 1:1, with a Money Laundering fee of 0.1%. According to Dune data, as of now, approximately 32.9% of MakerDAO's Collateral is PSM-related assets, and 23.5% is RWA assets.
The profits generated by the RWA assets have significantly increased MakerDAO's profits, accounting for approximately 27.6% of the total revenue.
What are the risks and challenges of MakerDAO?
Based on the above figure, about 20% of the Collateral in MakerDAO is related to BTC or ETH assets. The stability of DAI depends on its value Fluctuation. Due to the unstable prices of BTC and ETH, this poses a challenge to maintaining a stable exchange rate between DAI Token and the US dollar.
When market Fluctuation leads to Collateral being insufficient to repay the debt, MakerDAO initiates liquidation through automated processes. If the liquidation process fails to generate enough DAI, the unpaid debt will be transferred to the Maker buffer pool. If the DAI in the buffer pool is insufficient, the system will initiate debt auction mint and sell MKR Token.
According to the above chart, PSM-related assets account for 32.9% of the current collateral assets of MakerDAO, while RWA assets account for 23.5% of the currency. This reliance on centralized stablecoins and real-world assets RWA may trigger regulatory risks and cause the Decentralized DAI stablecoin system to lose credibility.
MakerDAO relies on Oracle Machine to input price data into Smart Contract. Due to the slow generation speed of Blocks, Oracle Machine may have price deviations, which may force MakerDAO debt holders to liquidate due to inaccurate price inputs.
Summary
MakerDAO, as one of the most mature Decentralization applications on the ETH blockchain, achieves economic empowerment of Decentralization financial platforms through its unique dual token model (MKR and DAI). The platform allows users to use encrypted assets as collateral to generate DAI stablecoins, thereby participating in a variety of Decentralization financial activities. With the continuous expansion of technology and applications, MakerDAO has broad prospects for future development and may continue to play a leading role in the field of Decentralization finance.